Chris Gardner is a huge believer in the “Internet of Things.” In case you’ve been living under a rock the past few months, that’s the hottest computer industry catch phrase. It refers to the idea of how cheap, fast and small computer chips will help dumb devices talk to each other – and you. As in ring, ring, your cell phone is telling you the baby has wet diapers. Or it’s raining outside and you don’t need to tell the sprinkler to turn off. Gardner is chief executive of Vitesse Semiconductor Corp., a small Camarillo chip maker with a troubled past that raised $28.7 million this month in a secondary stock offering in a big bet on that future. The money will be used to cover working capital and to pay down a looming debt call later this year. But it’s really all about positioning the company to prosper in a new interconnected world where its chips should be in demand. “We won’t be in that thermostat or heart monitor, but they have to connect to something,” Gardner explained. “We will need bigger pipes on the Internet, and that’s where our technology will come in. Bandwidth growth drives our business.” Vitesse currently makes integrated circuits for Ethernet routers and switches used by telephone companies, Internet services providers and corporations. Translated, that means common in-house uses of Vitesse technology include routing video from security cameras or connecting an office’s desktops to a printer. The company doesn’t make any consumer or industrial devices, just the circuit board components for manufacturers. Its customers include Alcatel-Lucent, Cisco Systems Inc., Ericsson and Hewlett-Packard Co., which pay anywhere from $1 for a tiny chip to $100 or more for a high-volume switcher. While the company’s portfolio of old circuits, used for phone calls and low-bandwidth information on the Internet, are declining in sales, its new circuits that can handle streaming video and other high-bandwidth data are increasing. In its most recent quarterly filing, the company reported that for the first half of its fiscal year, the number of new customers using Vitesse circuits increased 40 percent compared to the previous year. Gary Mobley, an analyst at Benchmark Co. in St. Louis believes that dwindling sales for Vitesse’s old products has masked the company’s progress in developing new products. “We believe the company is now at the tipping point as new product revenue is large enough and growing fast enough to overshadow the continued gradual decline of ‘mature’ product,” he wrote in a note to investors on May 20. He rates Vitesse a “buy” with a target price of $5.50. It closed June 25 at $xx.x on the Nadaq, giving the company a market cap of $xx.xx. However, the company continues to lose money. In 2009, Vitesse had an enormous net loss of $194 million on revenue of $168 million. Since then, losses have narrowed but revenue has trended down. Last year, the company reported revenue of $104 million and a net loss of $22 million (-55 cents a share). Bandwidth growth To turn around those losses and grow revenue, Gardner is betting on the Internet of Things. On the industrial side, Gardner uses the example of an oil refinery where hundreds of valves, pressure monitors and thermostats will feed data to a central computer via wireless Internet connectivity. The same model applies to factories, transportation systems and the electricity grid. Vitesse expects its components will appear in many of the routers and switches for industrial users. On the consumer side, the house of the future will have the heating, air conditioning, lawn sprinklers, lighting, security alarm, cameras, baby monitors, computers, cell phones and even watches connected. Vitesse doesn’t plan to make the small chips for many of these applications, but will engage in the large central computer that coordinates the devices. Gardner estimates that a startup in semiconductor sector takes 10 years to reach profitability. He views Vitesse as 30-year-old company that has restarted, and is only about halfway through that process to reach profitability again. Each new integrated circuit takes about three years to design and reach the prototype stage, he noted. Then customers have to incorporate the chip into their products, which can take another year or two. “So the path to revenue is five to six years. At this point, we’ve done the heavy lifting,” Gardner said. “With the new products a large percentage of our revenues – more than 60 percent – will drop to the bottom line. We can see that in 2015 and 2016.” Still, there are questions about the strategy. Ron Maltiel, owner of RMG and Associates, a semiconductor consulting firm in Saratoga, said the challenge for a small company such as Vitesse is arriving first to market with an innovative product. But even that accomplishment doesn’t guarantee success. “When you have new market like the Internet of Things, nobody knows where it’s going,” he said. “To be successful, it’s not just a matter of designing a good product. Your customer has to be successful, and their product has to take off.” Quinn Bolton, an analyst at Needham & Co. in New York, wonders whether Vitesse’s competitors, including Broadcom Corp. in Irvine and Marvell Technology Group Ltd., in Hamilton, Bermuda – companies both with multi-billion-dollar market caps – may seize a good chunk of the new business. “We believe (Vitesse) management’s goal for new product revenue of $55 million in fiscal 2014 appears challenging,” Bolton wrote in a May investors’ note. “Increased competition could result in pricing pressure, reduced profitability and loss of market share.” To bolster his case, Gardner cites figures from the company’s most recent quarterly report showing that 46 percent of revenue comes from new products. He expects growth to continue for the rest of the year and throughout 2015. “And as we go forward, new products will become bigger part of our revenue” he said. “We are on the verge of breakeven today.” Capital concerns Vitesse was founded in 1984 by Louis Tomasetta and several partners. Tomasetta eventually became chief executive but was fired in 2006 for illegally backdating stock options. The U.S. Justice Department brought criminal charges and after several mistrials, Tomasetta and the former CFO were convicted and sentenced in December to a fine and probation. The board hired Gardner in 2006 to fix the company both financially and with its customers. He took over with a debt load of $155 million, a figure that management has shrunk to about $50 million. In February, the company retired $13.7 million in debt, paid for with money from a secondary offering last summer. But in October, the company must pay back $32 million and in August 2016 another $17 million. Gardner said the company will have $32 million in cash by October, but that would have left almost zero in the bank account. To avoid a cash crunch, he decided to raise $28.7 million earlier this month in a secondary offering. Of course, the offerings dilute the value of shares. And Bolton, the analyst at Needham, noted in his report that the two liquidity events in the future involve debt the note holders could turn instead to shares. “If converted into equity, the (loans) pose a dilution risk to current shareholders,” he wrote. Despite any near-term misgivings, Bolton gives the stock a “buy” rating with a target price of $4.25. Gardner doesn’t expect another secondary offering in the foreseeable future. He noted that since the offering last year and the one this month, the stock’s price has increased 49 percent. “The big challenge is to get through this transition of the next couple quarters,” he said. But people like the transformation of the company. As we take care of the balance sheet and de-risk the stock, it makes us a nicer investment for a lot of folks.”